It seems like everyone has been making it big in the stock market the last few years.
From 2021’s AMC and Gamestop meme stock craze to the explosion of NFTs and the countless anecdotes of people quitting their day jobs to day trade, you may be feeling left behind if your portfolio isn’t crushing it.
And it’s kinda true — almost everyone really has been crushing it the last few years (up until just recently with all that’s been happening in the world).
To give you a sense of how easy the market has been, between January 1, 2019, and March 29, 2022, the S&P 500 was up 85%, with the Nasdaq 100 up an even higher 140%.
Even more, as of March 23, 2021, 95.9% of the ~3,000 stocks in the Wilshire 5000 Total Market Index had a positive total return over the prior 12 months. No other one-year period has come close to that since the end of February 2004, when 93% of stocks had positive 12-month returns.
So, yeah. It’s been fairly easy to make money in the stock market.
And with Millennials and Gen Z plagued by student loans and financial uncertainty, it’s tempting for new investors to take on more risk to catch up to their desired financial goals. Sound familiar?
If you are a new investor who has experienced some market gains or are trying to maximize returns on platforms like Robinhood or Webull, it’s never a bad time to step back, evaluate what you’ve been doing, and see if you’re at risk of YOLOing away your savings.
Here are four questions to ask yourself.
1. Do you know what a realistic market return should be?
While it might not seem like it, the average return of the S&P 500 (the typical standard for U.S. market returns) historically has been ~10.5% annually (before inflation) for the last century.
That probably seems low given what many have experienced over the past few years. And you wouldn’t be alone in thinking so.
A recent survey of individual investors by Natixis Investment Management found that U.S. investors expect to earn an average after inflation annual return of 17.5% over the long term, significantly higher than the expectations of professional investors and what has materialized historically.
Why is this important when it comes to not YOLOing your savings away?
As an investor (especially as a beginner), you should always have clear, realistic expectations about what market returns are. By arming yourself with this information, you will be forced to think more critically about how you put your money to work — because generating more returns usually requires taking on more risk.
Every professional investor out there measures themselves to a benchmark and that benchmark drives their investment strategy.
To avoid putting yourself in a potentially bad situation, make sure you know what you should be measuring yourself against.
2. Are you investing or trading?
To many new investors, “investing” might mean something very different today than it did originally. “Investing” historically meant putting your money to work for the long-term using a buy-and-hold strategy.
Trading, conversely, is about generating short-term returns through buying and selling stocks or other financial assets like options.
You may think, based on recent events, that the best way to sustain big returns is through trading — and that by trading, you’re an investor. Don’t confuse the two.
Years of research on this topic has concluded that most individual stock pickers rarely outperform the market and active traders end off far worse. For example, a recent study of day-traders found nearly 80% of them lost money over a 12-month period with a median loss of 36%.
While it’s possible to juice your returns through trading, long-term diversified investors who avoid unnecessary risk and seldom trade are almost guaranteed to come out ahead.
If you want to avoid YOLOing away your savings, know the difference between trading versus investing and only allocate money you can afford to lose to high-risk, high-reward trading activities (everyone does need to have a bit of fun sometimes, after all).
3. Do you know your risk tolerance and risk capacity?
How would you feel if you lost $5,000 and the next day, you needed to pay for an unexpected expense, like your car breaking down? Would you still be able to pay that expense easily?
This scenario hits at the heart of the distinction between risk tolerance and risk capacity.
Risk tolerance is your emotional ability and wherewithal to take on risk (and incur potential losses) to meet your financial goals. It’s a choice that one can make in seeking higher returns.
Risk capacity is your ability to manage losses financially.
In the above scenario, if you lost that $5,000 because you bet on a hot stock (knowing you could lose it all), that means you have a high-risk tolerance.
If, however, in losing that $5,000, you could not pay for your car repairs, you have low-risk capacity.
If you haven’t put some serious thinking into these two concepts and how they come into your investment decisions, you are likely putting your financial well-being and emotional well-being at risk.
This is especially true if you trade. To not YOLO away your savings, understand your true risk tolerance and risk capacity. Doing this will help keep you out of potentially sticky or painful situations.
4. Are you clear on what you own and why?
At the height of the meme stock craze, you may have come across many TikToks or Instagram stories of newbie investors claiming they have no idea what they were doing yet still making money.
During uncharacteristically good markets, it isn’t uncommon for these folks to hit center stage (despite how frustrating and unfair it might be).
I’m not saying you are one of those people (otherwise you wouldn’t be reading this article). But can you confidently look at your Robinhood portfolio and rattle off in detail everything you have your money in and why?
If you can’t, you are running a serious risk of YOLOing away your savings for multiple reasons.
First, if you don’t know what you have your money in, you’ve essentially entered a casino and stepped up to the roulette table.
The same holds true for not knowing why you’ve invested in what you have.
When times get tough, you likely won’t know if it’s a good idea to sell, buy more, or just stick it out. When times are good, you won’t have a sense of when to sell or just hold on.
I know it might be tempting on occasion to hop on the bandwagon of someone else’s new idea in the hopes of a big score, without doing your own research. We’ve all done it — myself included.
If both your risk capacity and risk tolerance are high, doing this on occasion can work out and even be fun. But overall, if you don’t want to YOLO away your savings, get clear on what you own and why.
Featured image: ComicSans/Shutterstock.com
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